| New VAT on property regime - will it impact the market? |
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| The Revenue's Pro-Forma text, published in March, clarifies detail around the proposed new system of VAT on Property. Whilst some aspects of the proposals are positive, there are also practical concerns which need to be addressed to avoid adverse market implications. The recent announcement of some 'grandfathering' provisions is welcome however. |
Property is in the news a lot these days. While the reform of stamp duty is a topical talking point, a very fundamental reform has been proposed in the area of VAT and property legislation. Its potential effect on the financial position of companies and thus the commercial property market should not be underestimated.
We provided a summary of the key features of the proposed new regime in the February edition of Tax Monitor. Here we focus on whether the proposed Pro-Forma text achieves the stated objectives of ensuring that the status of a property for VAT purposes be readily apparent and that the system for taxing property transactions be simpler but more robust.
Market uncertainty
The legislation is not anticipated to take effect until July 2008 at the earliest. However many transactions being signed now will not complete by then. The fact that the final provisions of the new system are still subject to change means that landlords and tenants are effectively being asked to sign up to a lease without the certainty of knowing exactly what VAT treatment will apply to it. This has given rise to considerable uncertainty and unease which is undesirable, especially in the current market.
In these circumstances, there has been considerable concern about the lack of a sufficient ‘grandfathering’ regime. Take, for example, the position of a partially VAT exempt financial services company entering into an agreement now to take a lease of a new building which may not be completed until some time in 2009. Under the original proposals, the landlord would have had to apply the new regime to the transaction which would mean he would not have been able to opt to apply VAT to the rents because the tenant does not have at least 90 per cent VAT recovery. Furthermore, the landlord would have suffered a clawback of any VAT that he incurred when he bought the building and would have sought to charge this to the tenant, either as a lump sum or as additional rent. Either way, this would have significant commercial implications for both the landlord and tenant.
However, following submissions to Revenue and the Department of Finance, including significant submissions from KPMG, a welcome step has been taken with the announcement, on July 26th,, that a ‘grandfathering’ regime will be incorporated into the new system. While there are certain conditions which must apply, essentially the Department of Finance and Revenue have confirmed that deals agreed prior to the publication of the Finance Act 2008 can apply the current VAT regime. This ‘grandfathering’ regime does not apply to all deals but is specifically targeted at leases to ultimate tenants with less than 90 per cent recovery, which is the area that was causing the most concern in the market. In order to benefit from the transitional arrangements, the landlord must notify the Revenue in writing before the passing of Finance Act 2008 of his intention to avail of them. While there are certain points of detail which still require clarification, this ‘grandfathering’ announcement will go a long way towards easing the concerns which were being raised in the marketplace.
Simple and robust system?
In order to be robust, a VAT system must be practical as well as relatively simple to operate. There are a few aspects that raise question marks in this regard. For example, the proposals introduce a Capital Goods Scheme. In short, the scheme deems property to have a 20 year ‘life’ for VAT purposes and provides for annual adjustment of the initial recovery of VAT based on the use of the property during its VAT life. Where a purchaser’s initial VAT recovery was restricted, a credit is allowed for an element of the disallowed VAT where that person makes a subsequent VATable sale of the property. The concept is welcome and has been successfully introduced in several EU Member States.
The Capital Goods Scheme proposals encompass refurbishment costs which are defined very widely with the result that it is unclear as to what might be included. Such costs are subject to a different adjustment period of 10 years, compared to 20 years for acquisition VAT. This is likely to give rise to difficulties in practice.
The proposed system radically changes the old position where, broadly, the VAT treatment of the sale of a property revolved around whether the vendor had a right to deduct input VAT and critically, whether the property was developed (in which case it normally remained liable to VAT almost indefinitely). Now, the VAT treatment varies depending on whether the sale is the first or subsequent sale within five years of completion of a new building, a sale between five and 20 years or a sale outside of 20 years. A full history of the property is necessary, including specific dates of completion, occupation, previous lettings etc, and this is only to determine whether VAT is chargeable. Determining the amount on which VAT applies is even more complex. Under the proposals, for opted sales, the amount will be based on calculations related to the amount of VAT initially paid by the vendor not by reference to sales price.
When it comes to finalising a deal, a potential purchaser needs to understand what the property will ultimately cost. A stated aim of the regime is that the VAT status of properties be readily apparent. However, to establish the VAT status and hence the cost, the purchaser will now need to obtain the history of all transactions associated with the property, what amounts were spent, what the VAT recovery position of the vendor was etc. Purchasers are unlikely to want to rely on informal confirmations where significant sums are at stake, so protracted correspondence between the parties’ legal representatives will ensue to obtain the necessary confirmations as to the basis and amount of VAT being charged on any transaction. Some parties will probably seek comfort in the form of Revenue rulings on what should otherwise be straightforward transactions, which may cause un-necessary additional delays.
Equally, in relation to lease transactions, landlords will need to obtain confirmations and evidence as to whether all their proposed tenants have greater than 90 per cent VAT recovery to determine whether they can opt to tax. They will need to continually monitor this position throughout the period of the lease. This involves monitoring not only the tenants’ recovery but that of any person the tenant decides to sublet to. Imagine the difficulty faced by a landlord of a multi-tenanted shopping centre or office complex where leases are continuously changing hands. Inevitably, landlords will start imposing conditions on tenants in terms of the use to which a property can be put and restricting rights to assign or sublet which could adversely impact the market. These aspects of the system, as currently proposed, run the risk of causing additional complexities in practice and giving rise to otherwise unnecessary restrictions on property transactions.
Increase in VAT burden?
Where a tenant has less than 90 per cent recovery, the VAT cost will be trapped at the level of the landlord. Either the landlord will bear this burden or he will seek to pass it onto the tenant. If he passes it on by way of additional rent, he will need to be compensated to cover his increased income or corporation tax liability. Alternatively if he seeks a once-off reimbursement payment it could be subject to stamp duty as well. One party or other ends up bearing increased cost. Therefore this is likely to lead to a dual rental market where landlords charge a higher rent to tenants where they cannot opt to tax compared to that charged where they can charge VAT.
What impact a dual price rental market may have on the market in general has yet to be seen.
Furthermore, the proposals seem to restrict the ability to cancel the option to tax in certain circumstances, following the introduction of the new rules. Even if the 90 per cent restriction was lifted, a VAT exempt financial services company, for example, who would currently pay 13.5 per cent VAT upfront on the capitalised value of the rents, would in future pay 21 per cent VAT on rents charged for the full term of the lease. The net impact is that this could treble the VAT cost on say a 25 year lease.
On the whole
Any initiative to simplify the system of VAT on property is welcome and, at the core of these proposals, there is a probably a workable system. The attempt to deal with the double VAT charge that can arise where a partially exempt business acquires, and subsequently disposes of, an interest in property is welcome. The change to calculate VAT chargeable on sales on the basis of VAT amounts initially paid by the vendor as opposed to the sale price is welcome in so far as it halts the indefinite increase of VAT costs as buildings increase in value. Of course this is only an advantage if there continues to be a rising market.
In addition, the recent announcement of ‘grandfathering’ provisions aimed at easing uncertainty concerning deals being signed now but which will not be closed before the new regime takes effect is also very welcome.
However, a number of the concerns set out above still need to be addressed. The complexities of the current system are well recognised and there is a wide body of experience to be drawn from. Any complexities of a new system could have a disproportionate impact on the ease with which property deals are done and therefore on the market itself.
The opportunity for industry consultation in the detailed legislative proposals has been very valuable. Consultation continues and I would urge any businesses which have not reviewed their position under the proposed changes to do so now in order that any specific concerns may be identified and highlighted as soon as possible. |
Niall Campbell is a partner in KPMG’s indirect taxes division.
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| Article appeared in the August 2007 issue.
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